The domestic VAT reverse charge applies to sales of construction work from 1 March 2021. The VAT reverse charge for the construction industry is effectively an extension of the CIS. It applies only to transactions between VAT registered contractors and sub-contractors who are registered for CIS.
The scheme means that those supplying construction services to a VAT registered customer will no longer have to account for the VAT. Instead, the customer will account for the VAT.
Apply the reverse charge when all the following are met:
- The supply for VAT consists of construction services and materials.
- It is made at a standard or reduced-rate of VAT i.e. it doesn’t apply to Zero rated supplies.
- Between a UK VAT registered supplier and UK VAT registered customer.
- Supplier and customer are registered for CIS.
- The customer intends to make an ongoing supply of construction services to another party.
- The supplier and customer are not connected.
The CIS reverse charge does not apply to any of the following supplies:
- Supplies of VAT exempt building and construction services.
- Supplies that are not covered by the CIS, unless linked to such a supply.
- Supplies of staff or workers.
The CIS reverse charge does not apply to taxable supplies made to the following customers:
- A non-VAT registered customer
- ‘End Users’ i.e. a VAT registered customer who is not intending to make further on-going supplies of construction.
- ‘Intermediary suppliers’ who are connected, e.g. a landlord and his tenant or two companies in the same group.
For sake of clarity, HMRC says the VAT reverse charge for construction doesn’t apply to subcontractors unless the answer to all of the following questions is positive:
- Are any of the supplies you are making within the scope of the CIS?
- Is the supply standard or reduced-rated?
- Is your customer VAT registered?
- Will your payment be reported under CIS?
- Are you sure the customer is not an end user?
Example: how the CIS reverse charge works
John the roofer (who is VAT registered) supplies the materials and roofs a new office building for the contractor (who is also VAT registered). Who in turn, supplies its construction services to the developer (also VAT registered). The developer finds and develops land and will, in this case, bring the build to completion and supply a finished commercial building to End-user, its client.
- John the roofer would under the old VAT system, invoice the contractor £120,000, comprising of his £100,000 bill for materials, labour and works, plus £20,000 in VAT (at 20%).
From 1 March 2021, under the new CIS reverse charge mechanism, he invoices £100,000. His invoice states that “the CIS reverse charge applies” and that the applicable rate of VAT is 20%.
- The contractor pays John the net £100,000 fee. It then accounts for output and input VAT of £20,000 on the supply on its own VAT return.
- John does not account for output VAT in his accounting system as he has invoiced only his fee £100,000.
- As a consequence of the reverse charge procedure, John charges and receives £20,000 less than under the old system (where he would charge £100,000 + VAT) however he does not have to account to HMRC for any output tax on the transaction.
- When he is paid by he includes the value of the sale in box 6 of his VAT Return. He does not add VAT to box 1 as he receives no output VAT.
- The change may well impact John’s cash flow, as under the old rules, if the Contractor was a prompt payer he could hope that he could use the £20,000 in VAT to purchase his materials. He could then purchase his materials and offset the input tax paid against his output liability.
- The contractor has a cashflow advantage, it does not have to pay John £20,000 and then at the end of its VAT quarter it cannot reclaim £20,000 as it is accounting for the reverse charge and the output VAT offsets the input VAT.
- As the contractor is supplying CIS services it must also consider the reverse charge. Is the client (developer) going to be involved in the onward supply of CIS services? In this case, this may be difficult to determine as the developer is selling a finished building to the end-user. The end-user is an investor and the reverse charge does not apply. It is the developer’s responsibility to notify down the supply chain.
What services are within the CIS reverse charge?
- Constructing, altering, repairing, extending, demolishing or dismantling buildings or structures (whether permanent or not), including offshore installation services.
- Constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, part of the land, including (in particular) walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, docks and harbours.
- Pipelines, reservoirs, water mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence.
- Installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure.
- Internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration.
- Painting or decorating the inside or the external surfaces of any building or structure.
- Services which form an integral part of, or are part of the preparation or completion of the services described above – including site clearance, earth-moving, excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works.
- Drilling for, or extracting, oil or natural gas.
- Extracting minerals (using underground or surface working) and tunnelling, boring, or construction of underground works, for this purpose.
- Manufacturing building or engineering components or equipment, materials, plant or machinery, or delivering any of these to site.
- Manufacturing components for heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems, or delivering any of these to site.
- The professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants.
- Making, installing and repairing artworks such as sculptures, murals and other items that are purely artistic.
- Signwriting and erecting, installing and repairing signboards and advertisements.
- Installing seating, blinds and shutters.
- Installing security systems, including burglar alarms, closed-circuit television and public address systems.
Certain services can become included:
- If there is a reverse charge element in a supply then the whole supply will be subject to the domestic reverse charge.
- If there has already been a reverse charge service between two parties on a construction site, and if both parties agree, any subsequent construction supplies on that site between the same parties can be treated as reverse charge services.
- If there is doubt whether a type of works falls within the definition of a specified service, as long as the recipient is VAT registered and the payments are subject to CIS, the reverse charge should apply.
- The contractor is asked to consider all construction contracts with a sub-contractor. If they can see that reverse charge applies to more than 5% of contracts (by volume or value) with that sub-contractor, then the reverse charge may be applied to all the contracts.
Do invoices need to change when the VAT reverse charge for construction comes in?
Yes. Invoices should clearly indicate the reverse charge applies using the correct terminology. HMRC suggests businesses use any of the following:
- Reverse charge: VAT Act 1994 Section 55A applies.
- Reverse charge: S55A VATA 94 applies.
- Reverse charge: Customer to pay the VAT to HMRC.
It should be clear on the invoice that the reverse charge mechanism has been applied.
Your invoice should still show all the usual information required for a VAT invoice.
I’m a sub-contractor, what does the VAT reverse charge for construction services mean for my business?
If you’re a sub-contractor (i.e. you supply CIS-regulated construction services) then, in theory, it means very little because when you issue your VAT invoice. You will merely be passing on the VAT charge that you would have had to account for in any event.
But it might affect your cash flow because the VAT you previously held before passing it monthly/quarterly to HMRC as a payment will no longer be available for any uses you might have put it to.
Notably, because you no longer pay VAT on your sales you might find you become what HMRC calls a repayment trader—a business whose VAT Return means they claim money from HRMC, rather than making a payment.
HMRC suggests that such businesses apply to move to monthly returns, to speed up payments received from HMRC and therefore benefit cash flow.
I’m a contractor, what does the VAT reverse charge for construction services mean for my business?
If you’re a contractor (i.e. purchase CIS regulated construction services) then, in theory, it means you need to ensure that when you receive reverse charge VAT invoices you correctly account for them.
You may gain a cash flow benefit because the VAT you previously had to pay when paying sub-contractors, but could not reclaim until your next VAT return, is simply netted off in your VAT return. There should be no net impact on your overall VAT bill.
However, to ensure you don’t pay too much or too little VAT you will need to ensure the invoice you receive is correct, especially with regard to the correct VAT rates, and you’ll need to ensure the services listed are eligible for the reverse charge.
How does the construction reverse charge impact businesses on the flat rate scheme?
Reverse charge supplies are excluded from the flat rate scheme so should be accounted for and reports the same way that transactions are accounted for and reported under the standard scheme.
This will reduce the amount of turnover that is used as a basis for reclaiming VAT under the flat rate scheme and sub-contractors may want to discuss this with their professional adviser to reassess which of the standard or flat rate schemes are most beneficial.